Investment: risk and reward

Investment returns

The returns earned on pension fund investments are made up of two components – an income return from dividends or interest earned and a capital return based on the movement in the price of the underlying assets which can be positive or negative depending on whether price goes up or down. A real return is the return earned on an investment above inflation. For example if an investment achieves an absolute return of 9% and inflation is 4%, then its real return is 5%.

Your need for investment returns will generally depend on your type of pension arrangement and how far you are from retirement.

Good investment performance reduces the cost and enhances the security of benefit promises in funded defined benefit schemes, and increases the amount of benefits in defined contribution schemes, personal pensions and PRSAs. Poor investment performance has the opposite impact.

It is therefore, important that you know how the investments in your pension fund are performing over the long term.

The following illustration shows the impact of a higher return over the lifetime of a pension saver. In this example achieving an investment return of 6%p.a. produces a pension fund at retirement more than 50% higher than one earning a return of just 4%p.a.